Misconceptions/Finance for Dummies: No, banks don’t necessarily get more return on loans when rates go up!

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Don’t worry about them, banks make money, no matter if the rates are low or high… The only big risk is the non-repayment of loans.

Do you have to be a banker to know this?

Obviously, no journalist or financial influencer has ever been a banker in a past life… The job of a retail bank is to sell money to individuals and businesses, this is called credit. The bank’s margin on loans arises not only from the difference between the rate at which it receives the money it lends and the rate at which it sells that money. The bank’s profit is derived from the principle that the bank will lend it up to 13 times for the same euro. The margin on the difference between the applied rates changes little, regardless of whether the rate level is low or high. Therefore, for banks, the volume of loans issued is more important than the difference between buying and selling money.

Historically low rates, and yet… The detail should have shocked you

If you still think that bank profits rise significantly as interest rates rise, you have to ask yourself how banks managed to make all those billions of euros in profits (see bank results and earnings) in years when interest rates were below 1%. ? It’s amazing that everyone knows that commissions from business representatives are about 1% of the amount of borrowed capital, isn’t it? Well no, not at all.

During these periods of extremely low rates that we have experienced in recent years, retail banks have never made so much profit on loans. How, then, to explain this tenacious idea that banks will earn more profits in times of high interest rates? There have been periods of very high interest rates in the past, but banks have never made as much profit as they did during this period of low interest rates. In fact, the higher the interest rates, the less banks sell loans., very simply, as the risk of default increases exponentially with rates, fewer borrowers complete all fields to borrow. And as a result of the reduction in the volume of loans issued, banks make less money, because their volume of money sold is weakening.

Profits not directly attributable to changes in interest rates

This can be confirmed by any experienced banker. Changes in interest rates are not the main criterion for fluctuations in bank profits. More important is the amount of loans issued.. And contrary to what the financial media regularly reports, raising interest rates is pretty bad news for banks. If their margins can increase without customer complaints, the amount of credit provided will be reduced. Paradoxically, in the stock market, bank securities rise in value when market interest rates rise. The Pavlovian reflex is of the same kind as during periods of fear when gold emerges as a safe-haven investment. There is no rational sense in this, but such are market habits.

Back to the vertical financial world

With the financial world going upside down with negative rates, it’s over! This stimulating effect on bank securities is not due to the profits made on loans during the rate hike, but to the fact that banks are less affected by the ECB’s margin restrictions. This is the cost of financial assets that provide a level of guarantee (AAA), which will now be cheaper. Credit lines from the French state at negative rates have ended for several weeks. The ECB recently confirmed its key rate hike schedule, the break is over. Let’s get back to the financial world from the right side.

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